DBRS Confirms Loblaw at BBB, Trend Stable

DBRS has today confirmed Loblaw Companies Limited’s (Loblaw or the Company) Medium-Term Notes and Debentures ratings at BBB, its Cumulative Redeemable Second Preferred Shares, Series A rating at Pfd-3, and its Commercial Paper rating at R-2 (middle). All trends remain Stable. The ratings reflect Loblaw’s strong market position, large scale and national diversification, balanced by the mature nature of the core business.

Loblaw’s earnings profile has stabilized in H1 2011, after a period of improvement in 2009 and 2010, as the Company began to see the benefits of its five-year renewal plan. Revenue declined moderately in H1 2011 on the basis of moderately negative same-store sales. This followed a 0.9% increase in revenue in 2010, which was primarily the result of sales from T&T Supermarkets Inc. (T&T; acquired in Q3 2009), offset partially by a small decline in same-store sales. EBITDA margins, on the other hand, improved for a fourth consecutive year, increasing 40 basis points (bps) in 2010 and an additional 30 bps in H1 2011, ending the period at 6.8%. This positive trend is the result of continued improvements to labour and other operational efficiencies in combination with the Company’s acquisition of T&T, a traditionally higher-margin business.

Loblaw’s financial profile has improved in line with the recovery in operating income witnessed since 2009. Free cash flow before changes in working capital continued to show improvement in H1 2011, while capex began to stabilize, albeit at a higher level than the previously considered norm, resulting in relatively stable debt. Combined with rising EBITDA, this has led to a moderate improvement to credit metrics during that time period.

DBRS believes that Loblaw’s earnings profile should remain stable over the near to medium term, despite increasing competition from U.S. retailers and rising input costs. Top-line revenue is expected to increase in the low- to mid-single-digit range over the near to medium term, based primarily on a return to an inflationary pricing environment. Margins are likely to come under pressure through the end of 2011 and into 2012 as rising input costs resulting from food inflation may be difficult to pass on completely to consumers in the current competitive and economic environment. Pressure on margins may be partially offset by benefits associated with cost-cutting and efficiency-focused initiatives. As such, EBITDA should remain relatively flat or only increase moderately through 2012.

In terms of financial profile, DBRS expects Loblaw to remain at least stable. Cash flow from operations should continue to track operating income, while free cash flow before changes in working capital is expected to remain positive, benefiting in the longer term from moderate declines in capex. DBRS believes that in the long-run Loblaw will use its high levels of cash on hand and short-term investments, as well as free cash flow, to either invest in growth and/or return value to shareholders, which should lead to stable debt and credit metrics. Loblaw is considered to be a strong credit within its current rating category; nevertheless the Company has the potential to further improve credit metrics with growth in operating income and cash flow and/or the application of free cash flow to debt reduction.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Companies in the Merchandising Industry, which can be found on our website under Methodologies.